Importance of smart contracts

Smart contracts represent self-executing contracts wherein the terms of an agreement between the seller and buyer are written directly in the form of computer code. The agreement and the code are then entered into a centralized, distributed blockchain network. Smart contracts allow trusted agreements and transactions to be executed among anonymous, disparate parties without the involvement of a central authority, external mechanism of enforcement or legal system. They also render such transactions transparent, traceable and irreversible.

Though Blockchain was reckoned as the underlying technology that drives Bitcoin, it is now getting recognized as the technology that can disrupt many traditional ways of business and governance.

Early days of smart contracts

An American computer scientist, Nick Szabo was the first to propose smart contracts and later in 1998, he invented “Bit gold” a virtual currency, a decade before Bitcoin was invented. As a matter of fact, it is often rumoured that Szabo is the real inventor of Bitcoin under the pseudonym Satoshi Nakamoto though Szabo has always denied the assumption. Smart contracts were defined by Szabo as a computerized transaction protocol that can execute the terms of any given contract. He was keen on extending the functionality of electronic transactions like POS to the digital world. A paper presented by him proposed execution of a contract covering synthetic assets like bonds and derivatives. He wrote that the new securities are formed through a combination of securities like bonds and derivatives like futures and options in a wide range of ways. Standardized contract could now carry pretty complex term structures with regard to payments and the transaction costs for trades pegged very low, thanks to the computerized analysis of the complex term structures. In simple terms, he was referring to the purchase and sale of derivatives with complex terms. Many of the predictions made by Szabo in his paper also came true in situations preceding the evolution of blockchain technology. For instance, derivative trading largely relies on computer network with the help of complex term structure.

In the real world execution of agreements involving multiple stakeholders, a third party verifies and scrutinizes all information making it a time-consuming and complex process. With smart contracts, the role of the third party is eliminated and the process of verification and scrutiny are automated and the stakeholders can transact with each other directly. Smart contracts also present the convenience and freedom to transact business with interested vendors/parties from across the globe without the intervention of trustworthy middlemen or verifiers. The encryption mechanism inherent in the smart contracts ensures trust, security, tamper proof process and trust.

Examples of smart contract application

In the last couple of years, blockchain technology which is integral to smart contracts has risen to be a disruptive force impacting a cross section industries like banking, telecommunication, insurance, education, entertainment, health and e-governance. Therefore, let us now examine examples of how smart contracts impact industries and governments.

Governance: One way smart contracts can bring radical transformation to governance is introduction of transparency in the taxation process. Presently, salaried employees pay taxes through their employers who are acting as intermediaries to collect and co-ordinate related information. Smart contracts can wholly automate this process and employees can directly enter particulars of their income to a tax portal of the government. The portal can calculate tax to be paid by the employee with data provided by him and automatically deduct tax from the employee’s earnings short circuiting intermediaries entirely leading to a cost efficient, simple and timely and transparent processing of tax using the payroll system.

Healthcare: The healthcare industry faces perennial problems from data exploitation, data tampering and middlemen. These problems can be squarely addressed by introducing smart contracts in the health records of patients. Patient records are critical in diagnosing disease as well as preventing wrong drugs from being administered. Apart from these, they also carry sensitive data that can potentially be misused by malicious or overzealous marketing purposes. With digitization and encryption of patient records, smart contracts can limit the access of information only for authorized persons thus ensuring that the data does not get into wrong hands.

Education: There are multiple ways in which smart contracts can bring a sea change to the education sector. Student records, badges, and certificates with only authorized access is one measure that can enhance transparency and trust. Another potential use is tracking and validating faculty and student attendance for sanctioning course credits for students and salary for faculty in terms of hours recorded through the system. This is another measure that ensure transparency and reduces paperwork. Smart contracts are also helpful in distributing scholarships to students by coding the stipulated criteria in the system and awarding the scholarships subject to all conditions being met by the particular student.

Supply chain: Supply chain management across the globe is already undergoing revolutionary changes, thanks to smart contracts. A singular version of truth for every stakeholder in the system that is resilient and fraud-resistant enhances the efficiency of the entire supply chain. Such a system is helpful in managing approval of workflow, authorizing material transfer automatically upon completion of all the formalities necessary and encoded in the smart contract. Businesses can also conveniently bye-pass traditional methods of creating trust leading to savings in money and time apart from reduced paperwork and the role of middlemen.

Fintech industry

Blockchain technology and smart contracts have already made a disruptive presence in the fintech industry. Ripple has pioneered several solutions for cross border payments and a number of global banks have lapped up the technology within a short space of time. In the banking sector smart contracts simplify and speed up the transaction process ensuring accuracy of information and enforcement of obligations on all parties.

The terms in a smart contract are fully transparent and they are also designed to execute exactly according to the terms they are expected to. Consequently, the potential for error in financial transactions is greatly reduced.